DUE DILIGENCE: FINRA’s Merrill Fine is a Tap On the Wrist

This week, FINRA fined Merrill Lynch $1 million for making it hard for former brokers of the firm to fight back in bonus disputes. That’s pocket change for a financial services leviathan like Merrill, which has paid as much or more out to individual brokers in come-hither money. But some attorneys said it sends the intended message to Merrill and other firms anyway: follow FINRA rules or else.

“It’s a drop in the bucket, but they’re trying to send a message that this is clearly defined territory,” said Sharron Ash, litigation and employment counsel for The Hamburger Law Firm, who represents brokers.

Back in 2009, Merrill wrote some $2.8 billion in bonus checks to hold onto top talent, right after the firm nearly imploded and was rescued by Bank of America. That same year 1,001 financial advisors departed the firm anyway, according to data from Meridian IQ. Some of them just couldn’t make it in the business anymore; many of them had seen their retirement nest eggs wiped out by the decline in Merrill’s stock price. The thing is, when they left, a number of those brokers didn’t pay back bonus money that was contingent on their sticking around. To get it back, Merrill filed over 90 actions in New York court in 2009.

As is common in the industry, the bonuses Merrill awarded to brokers in 2009 were promissory notes, which are structured as loans, forgivable over time as long as FAs keep their buts in their seats and continue bringing in client money. But these Merrill retention agreements included something else for the first time: they required brokers to resolve all disputes over bonus money in New York state court, where it is notoriously difficult to file counterclaims, instead of through arbitration as required by FINRA rules.

In other words, if a broker left before his contract period was up, and he either couldn’t pay back the remainder due on his loan, or felt he shouldn’t have to, it would be very difficult for him to fight Merrill to keep the loan money instead. Merrill tried to get around the FINRA rules by diverting the broker loan payments through an unaffiliated subsidiary of Bank of America, MLIFI.

Of course, nobody thinks deadbeat brokers should be able to just walk away with the money if they don’t hold up their terms of the deal. But sometimes advisors argue that the firm didn’t keep its promises.

“There is almost no defense to a breach of contract claim but often brokers are promised a lot—say, coverage of certain middle market accounts, and then they get there and they find out someone else has coverage of those accounts—they’re not producing, they’re dissatisfied, they get fired. So sometimes there are reasons,” says David Robbins, partner at Kaufmann Gildin Robbins & Oppenheim, who represents both brokers and firms in arbitration. Still it’s very difficult to win a case, said Robbins.

The funny thing is, promissory notes are already subject to a special expedited arbitration system, where only one arbitrator instead of three is required, and almost 95 percent of cases are decided in favor of the firms, according to Robbins. SIFMA, the banking and brokerage trade group, has even been pressuring FINRA to make it tougher for brokers to wiggle out of paying back bonuses—specifically it wants FINRA to change the rules so that brokers can’t plead poverty.

Sometimes brokers just get screwed anyway. Take Lehman Brothers. The Lehman Bankruptcy estate brought over 60 arbitrations against its former brokers for unpaid promissory notes, and they won almost every single case, said Robbins. “All kinds of counterclaims were brought and arbitrators ignored them.”

Merrill agreed to stop pursuing collection of promissory notes in New York state court in January 2010 and said it will not do it again, in statement that accompanied the settlement. But other firms could continue to use this formula. Unless they got FINRA’s message and feel $1 million is more than just a cost of doing business.